Should Restrictions on Gold Imports be Lifted?

Posted in Finance Articles, Total Reads: 2655
, Published on 27 February 2014

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As ‘humans can’t survive alone; at some point they will need the help of others’ this is also true about various economies. Countries trade among themselves by selling the goods and services at which they have an advantage and buy those goods and services at which they don’t. India has been actively involved in trading with other countries.

Exports and Imports:

When a country buys certain goods like crude oil, gold, etc. from other countries, the country is said to have imported that product. Whereas, when the country sells certain goods like iron, steel, rice, etc. the country is said to have exported that product. A country also exports and imports services. A country imports in order to meet its rising demand, else it would lead to roaring prices of that commodity which could have many drastic and severe effects.

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Much before, countries used to follow protectionist trade policy according to which the countries believed that for economic growth countries should export more and import less. For this the countries made the use of tariffs, quotas, etc. But as time progressed, other policies showed that both exporting and importing will help the country itself and as well as the other countries.

The difference between the exports and imports of any country’s goods and services is known as balance of trade. Balance of trade is a direct function of an economy’s current account. The current account balance indicates an economy’s health. And, the current account is also a direct function of the balance of payments.

Reasons for high demand for Gold and its Impact:

India is a country which has always been known for its culture. Having unique culture, Indians believe and pay more attention towards adorning themselves with ornaments on auspicious occasions like marriages, social gatherings, etc. Besides, festivals such as ‘Akshaya tritiya’ also lead to people buying more gold. Because of these reasons the demand of gold has always been high in India. This leads to an increase in imports which has negative repercussions on the economy, if not controlled.

India has continuously been importing gold in large amounts. This is because of the huge demand in the economy. Although, India produces gold but the supply of gold in India is far less than the demand of gold in India. The various ornament makers, people investing in gold, etc. these are some of the reasons for huge demand of gold in India. And thus to meet the high demand gold is imported in huge quantities. Another reason that is associated with high gold demand is related to black money. Black money is simply the money that is unaccounted for. Money that comes to various individuals from illicit activities can’t be deposited in banks or any financial institution. So either the individual keep it at their homes or invest in gold. And as a result the demand of gold is high.

Should restrictions on Gold Imports be lifted?

No, the restrictions on Gold imports should not be lifted. This can be said because of several reasons. Firstly, lifting restrictions on gold imports would mean that India would import gold in large quantity for satiating the country’s demand. Now as imports rise and assuming that the exports were same, it would have negative effects on balance of trade or one can say that the situation might lead to trade deficit in some future. Secondly, having negative effects on the balance of trade would have negative effects on the Current account balance of the country and would lead to balance of payment deficit.

Recently, Indian rupee took a worse hit, it depreciated to almost 68 Rs. Per USD. The government acted to this by imposing restrictions on the amount of gold that can be imported. The action taken reduced the imports and thus the Net Exports component or the balance of trade of the economy improved, and as a result the current account balance of the economy improved. As net exports improved there was an upward pressure on the Indian currency to appreciate. Thus the Indian rupee appreciated.

Now lifting those imposed restrictions might have negative effects like depreciation of the currency, balance of trade would take a severe effect, etc. A trade deficit leads to current account deficit and until and unless this deficit is offset by capital account surplus, it would lead to balance of payment deficit. And the balance of payment is entirely dependent on the exchange rate. There are a lot of factors which are responsible for the volatility of Indian rupee, some of them being current account deficit, insufficient inflow of foreign direct investment, rising imports, etc.

Because of restrictions on gold imports it gives rise to black market or smuggling of gold. When people are willing to invest in gold but the supply of gold is limited within the economy so various black marketers smuggle gold through Indian border and sell the gold at higher prices. This leads to an unwanted increase in money supply within the economy. And if this continues for a longer period, the economy can be shackled with high inflation.

Although not lifting the restrictions on the gold imports will have serious impacts on the trading partners of India. The most crucial trading partners of India are United Arab Emirates, Germany, United States of America and China. As India’s imports signifies the other countries exports. Thus imposing restrictions on important commodities such as gold will result in a situation where these countries would take a serious hit in their Balance of trade. Here the kind of policies that India adopts proved beneficial for India but it had negative repercussions on other countries. Such type of policy is known as beggar-thy-neighbor policy.

Considering a scenario, where assuming that if the gold imports are lifted what will happen. As gold accounts for almost 26% of the total imports so lifting the restrictions would simply mean that the imports would rise (It is assumed that the demand of gold remains the same as it was at the time when restrictions were imposed). Now the payments of these imports would have to be made in US dollars. Thus the demand of US dollars would increase than the supply of US dollars in the Indian economy. And as a result the US dollar would appreciate with respect to the Indian rupee and the Indian rupee would depreciate. It is now when the Central Bank of India – the RBI uses its one of many weapons. Actually when these US dollars are purchased, they are purchased in exchange of Indian rupees which means that the money supply increases. If this money supply is unchecked it would result in inflation. Hence to keep a check on the inflation, the RBI mops up this excess supply of money by selling gilt edged securities, this decreases the money supply within the economy. This process is known as Sterilization of capital flows and is considered as a powerful measure against keeping a check on both the exchange rate and as well as the money supply within the economy. Also, the depreciated rupee will be beneficial for IT giants and as a result exports would be boosted. But every industry has production constraint and they would not be able to produce more than a fixed quantity which would mean that the supply of their services would be limited whereas the demand of their services would be high. (Sujay Mehdudia, April 2013).

Gold has always been considered as an alternative of Indian rupee because of its fixed high return. People tend to invest more on gold because of this reason and because of which the demand has continuously rising. The demand of the gold has an inverse relationship with the Indian rupee. This means that more the gold is being bought; it will have an indirect effect on the devaluation of the Indian rupee.

Gold is a highly liquid asset. Because of its high liquidity people tend to invest more in gold rather than depositing in any financial institution. Depositing money in financial institutions esp. banks helps in increasing the money supply within the economy. So lifting the imposed restrictions on gold imports would mean that people would start buying more gold instead of investing it in other securities. Hence government should not lift the restrictions on gold imports as it will allow the people to invest their money in other securities or they’ll deposit their money in the banks.

From the aforementioned discussions it is evident that both lifting and not lifting the imposed restrictions on gold imports will be advantageous and as well as disadvantageous. The present situation will help to take a better decision. And the present situation is that the Indian rupee not stable enough, lifting the restrictions now would simply further increase the current account deficit of India.

Conclusion:

Presently, lifting the restrictions on gold imports would tantamount to slaughtering the Indian economy whereas imposing restrictions on gold imports would mean the suffering of other well established economies. Thus, restrictions must be imposed on gold imports in proper amounts which prove desirable for both the Indian economy and as well as other eminent economies.

This article has been authored by Neetesh Dohare and Ayush Dwivedi from IIM Udaipur